Thesis statement: Despite the Efficient Market Theory's assertion that it is

impossible to beat the market, real-life evidence of outperformance suggests a

discrepancy with the theory, prompting a reevaluation of its applicability in
practical investment scenarios.

Introduction

This paper defies the persistent claim of the Efficient Market Theory (EMT) that
“beating the market”[a] is an impossibility, the consistent occurrence of real-life
outperformance[b], ideas of Technical Analysis and Behavioral Finance, as well as
George Soros’ Theory of Reflexivity poses a compelling contradiction to the
arguments of the theory. This inconsistency elicits an examination of the EMT’s
theoretical premises and the realities observed in the financial markets.

Efficient Market Theory[c]

The Efficient Market Theory (EMT)[d] also known as the Efficient Market Hypothesis
(EMH) has long been heralded as a guiding principle that shaped how people viewed
the modern financial system. Conceived by Noble Peace Prize awardee economists
Eugene Fama and Paul Samuelson, the theory states that Financial Markets are
efficient and that all the information that concerns an asset is already reflected
in its price[e]. In the case of this paper, we will be focusing on Stocks of
individual companies.

In the idealized world envisioned by the EMT, the market price of assets reflects
every piece of information available at every given time, leaving no room for
investors to achieve superior returns often coined as “beating the market” through
the identification of mispriced stocks, the study of past price action patterns–
historical data of the changes in the price of a stock– and other analysis being
employed by market participants.[f] Thus the theory suggests that the price of an
asset at any given time accurately reflects the intrinsic value of the asset–the
present value of the company.[g]

For this paper, it is important to specify the difference between the intrinsic
value of an asset and the market value of an asset. The Intrinsic Value is a metric
used by analysts in analyzing a company. It estimates the genuine value of the
company including all of its assets, liabilities, and equities. Some utilize a
process called Discounted Cash Flow (DCF)[h], while others settle on the book value
of the company shown on its most recent balance sheet. The market value of a stock
is the price that it is currently trading at in the financial market. By the
premise of the EMT, the changes in the market value of the stock reflects
accurately the intrinsic value of the stock because the market participants' prices
in all the information that concerns the stock. [i]

The theory divides the efficiency of the market into three levels based on the
availability of information set that affects the security.

1. The Weak Form of Efficiency asserts that the historical price and volume
information of a stock is already priced in–already considered by the latest
transactions made by market participants–in the current market value of the stock.
Thus, it asserts that Technical Analysis–the study of previous price movements to
predict future action–futile in the pursuit of outperformance.
2. The Semi-Strong Form adds to the Weak Form that all publicly available
information, including historical figures reflected in the financial statement, is
already priced at the market price. Thus, Fundamental Analysis–the study of the
quality of the company the stock represents by examining its financial position,
growth, competitiveness, and other aspects that are considered crucial by the
market participant–is futile for the chance for mispricing is zero to none for the
EMT asserts that all information is already priced in the stock.
3. Finally, the Strong Form of Efficiency suggests that even insider information–
information only privileged individuals like the Executives, Board Members, and
Majority Stockholders are allowed to access–is already fully reflected in the
market price as soon as the information is conceived.

While the Efficient Market Theory provides a theoretical framework to understand

how the market works, does the reality of the financial markets align with its
claims? This paper seeks to argue against the claims of the Efficient Market Theory
by examining the claims of the three forms of market efficiency through empirical
evidence, dissecting historical market events, and evaluating the broader
implications of real-world phenomena that go against the claims of EMT.

The Random Walk Theory and its limitations:

The Random Walk Theory, one of the cornerstones of EMT’s arguments towards market
efficiency is characterized by the (1) independence of future price movements from
past price movements. It claims to describe stock prices to be akin to an
unpredictable path of random steps, hence the name Randon Walk Theory. Furthermore,
with its assumption that (2) new information is instantly and accurately priced in
the stock’s price, it concludes that markets are inherently efficient. However,
this idea fails to consider the intricacies of market participants who drive the
movement of the prices of the stocks. It oversimplifies the complexity of financial
markets. To invalidate the claim of the Random Walk Theory, understanding the
drivers of the market is imperative.

Liquidity as the Lifeblood of the Financial Markets:

Liquidity Flow, the flow of money in the market, drives the movement in the market.
If the liquidity is on the side of the buyers, the demand overpowers the supply.
When the demand is greater than the supply, prices tend to increase. On the other
hand, when the liquidity is on the side of the sellers, prices tend to fall due to
the overwhelming shares that sellers want to sell. This flow of liquidity is
propelled by the market participants–investors, traders, algorithms, institutions,
and market makers–who collectively make buy and sell decisions based on their
interests.[j][k]

Contrary to EMT’s claim that price movements are akin to a random walk and
impossible to predict, the markets are driven by non-random transactions influenced
by strategic, either rational or irrational, reactions of market participants. It
fails to consider the role of buying and selling decisions of market participants
that inject liquidity into the markets, creating trends, price patterns, and
fluctuations. As participants react to new information, trends emerge based on the
flow of liquidity, the price will either increase or decrease.

Having established that market movements are not entirely random, this challenges
the assumptions of EMT that future price movements cannot be predicted based on
past trends. This will further be discussed by the ideas of Behavioral Finance and
assumptions of Technical Analysis.
Implications of Technical Analysis and Behavioral Finance on the Assumptions of
EMT:[l][m][n]
[o]
Technical Analysis is the process of tracking patterns formed by analyzing the
chart of historical price movement along with the volume to evaluate investments
and identify opportunities by predicting future price movements. It asserts that
past market movements reflect the emotions and sentiments of market participants
harboring valuable insights in predicting future price action.

In tandem with TA, Behavioral Finance acknowledges the crucial human dimension to
the market dynamics. Contrary to the claims of EMT that market participants are
purely rational beings, it acknowledges that emotions play a pivotal role in
investment decisions and these reactions are often observable in recurring patterns
[p]that are reflected in the chart of price movements allowing market participants
to predict future price movements. This provides another invalidation to one of the
cornerstones of EMT, the randomness of market movements.

Soros’s Theory of Reflexivity:

George Soros is a Hungarian-American billionaire investor famous for profiting more
than 1 Billion Dollars overnight during the crash of the British Pound on September
16, 1992, often regarded as Black Wednesday. He gained international respect and
recognition for his successful Fund Management Firm, Soros Fund Management. [q]

His investment philosophy focuses a lot on reflexivity–the relationship between

thinking and reality–and the recognition of the role of participant perception in
shaping the market. His Theory of Reflexivity invalidates directly the claims of
EMTs that market participants operate rationally and that the financial markets are
efficient. He highlights a two-way exchange affecting the perception and reality of
human beings. From reality, we form our understanding and ideas of it, and this new
understanding and ideas affect the way we perceive reality, and this forms a loop
that goes on and on. According to Soros (2009), distorted views can influence the
situation to which they relate. He used the example of a drug addict being treated
as a criminal which in turn creates criminal behavior. He claimed that it doesn’t
deal with the problem but rather interferes with the proper treatment the addict
requires.

In relation to the financial markets, he claims that the beliefs and biases of
market participants influence the market fundamentals, creating a feedback loop
where the perception shapes the reality which affects the perception that again
shapes the reality, and so on. In support of Behavioral Finance, he contends that
markets driven by people are not solely driven by their rational and objective
reality, but rather are often irrational and driven by subjective perspectives.

When people think a company is bad, they tend to sell the shares of the stock. This
selling drives an overwhelming amount of supply into the market which causes the
price to go down, which in turn strengthens their perception that the company is
bad because its stock price is going down.

The illustration above shows the different psychological phases that market
participants undergo during a market cycle.

1. Actual firms/traders successful only using TA

2. Behavioral Finance
1. A lot of people trade a stock or enter the stock market because the prices
are rising. Therefore if the liquidity flowing into a stock is the cause of its
price movement, then the price movement is not independent of past price movements
of the stock.
3. Theory of Reflexivity
1. Soros argues that the relationship between market participant and the
underlying reality is more complex and can influence each other in a reflexive
manner.

Arguments against Semi-Strong Form of Market Efficiency.

Arguments against Strong Form of Market Efficiency.

https://www.cfainstitute.org/en/membership/professional-development/refresher-
readings/technical-analysis#:~:text=Technical%20analysis%20is%20a%20form,order%20to
%20make%20investment%20recommendations.

https://www.cairn.info/revue-de-philosophie-economique-2013-1-page-29.htm
https://www.ft.com/content/0ca06172-bfe9-11de-aed2-00144feab49a
[a]Provide a source of its meaning
[b]Define and clearly express what you mean by this.
[c]Need to Expound More on this and to give great sources
[d]Source
[e]Source
[f]Source??
[g]Differentiate intrinsic value and market Value
[h]Source
[i]Source??
[j]Source for this, there's an economic idea where every individual operates for
their own good, and in the bigger picture, it works for the market.
[k]You can expand this even further.
[l]This part alone already debunked the whole EMT, shit. Now we need to focus on
expanding it, making the idea deeper, providing more sources and examples, as well
as incorporating other ideas that will strengthen our position.
[m]Include the psychological cycle that market participants go through in the
market.
[n]How past prices affect future prices is not yet argued deeply.
[o]Deepen the arguments, add counter arguments, and strengthen the overall
position.
[p]Need a credible and strong support for this statement.
[q]Source